Banks, bailouts and texting and driving: James Saft

September 18, 2012

Sept 17 (Reuters) – The idea that a brush with death will
change a lucky escapee’s priorities apparently does not apply to
bailed out banks.

While you might be pulled from the smoking wreckage of your
car and decide to stop texting while driving, the banks which
got government injections of capital during the financial crisis
concluded, it would seem, that the problem was that they were
not pressing the buttons fast enough.

A new study by the Bank for International Settlements, the
so-called central banks’ central bank, shows that not only did
the bailed out banks not cut back on risk in their lending into
the syndicated loan market after being defibrillated by their
governments, they actually increased it relative to the market
and banks which did not get rescued.This is both astounding and totally predictable. Astounding
because it was so clear that those risks were not just foolish
but destructive. Predictable because of course the banks
realized that they had not been just lucky but had been given a
special exemption from death which will be very hard to revoke.

The study looked at the behavior in the syndicated loan
market of a group of 87 banks from industrial economies,
accounting for about half of global banking assets, 40 of which
took public capital. The syndicated loan market, in which banks
originate and distribute loans, is a key source of company
funding and is used to fund mergers, recapitalizations,
investment or simply ongoing corporate need.

Predictably, the banks which got bailed out were those
taking the biggest risks in the syndicated loan market before
the crisis, according to the study, making more leveraged loans
with high interest rates, and making loans with longer
maturities. Their loan books also got hit with more credit
downgrades after the crisis broke.

They were also, according to the study, not being paid
enough compensation for the risk before the crisis, not just in
absolute terms, which given the debacle is obvious, but even
relative to the go-go market in which they were operating.

“During the crisis, rescued banks did not reduce the
riskiness of their new syndicated lending compared to their
non-rescued peers. In fact, our results suggest that the
relative riskiness of their lending increased,” the authors of
the study Michael Brei and Blaise Gadanecz wrote.

Banks which did not take government coin cut their
participation in the riskier leveraged market by about a quarter
and made loans in with an average margin which was 36 basis
points less. Bailed out banks, in contrast, upped slightly their
share of leveraged lending and were paid higher rates. While
they upped pricing to make it better in line with risk, it was
by a small enough amount that it was not statistically
significant.

POLICY OR SELF-INTEREST

It is possible, of course, that getting banks to continue
making silly loans was exactly the intention of the bailouts.
After all, global funding markets reached a rate of near shut
down, and the knock on impact to the real economy was massive
and, much like the lending, indiscriminate. Interestingly,
bailed out banks raised loan prices more in their home markets
than abroad, so clearly they were not simply doing their
patriotic duty having been pulled from the fire.

And of course, the same set of incentives were still broadly
in place for bankers, though compensation was limited at some
firms which were bailed out. Since capacity was being
artificially supported, and since bankers get paid for doing
deals rather than not driving their firm out of existence, it is
only natural that those at banks with hard proof they would not
be allowed to explode would continue lending.

You could argue that the truly toxic combination is
too-big-to-fail status and zero interest rates. With rates at
virtually nothing at the short end, and not much higher two,
three or five years out, large banks can no longer count on the
sort of net interest margin which has been their traditional
lifeblood.

Today’s market is a big contrast to the late 1980s and early
1990s, when the U.S. banking industry was allowed to heal and
recapitalize, helped along by a big differential between where
they could borrow for short periods and lend for four or five
years.

Loan demand also simply is not all that great, especially in
the U.S., though there is a huge supply/demand mismatch in the
dicier parts of Europe. This has pushed banks towards using
their cheap borrowing privilege and ample liquidity to simply
speculate in the kind of propriety activity which proved so
expensive and embarrassing for J.P Morgan.

With the Fed pouring on more quantitative easing, and with
no real sign that too big to fail will be dealt with
effectively, moral hazard and risky banking seem to be more a
feature than a bug in the global financial system.

At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at)

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